Bank of England announces new mortgage constraints

The Bank of England has told mortgage lenders to limit the proportion of mortgages at loan to income multiples of 4.5 and above to no more than 15% of their new mortgages.

It has also said that lenders will be required to check their borrowers' affordability against an assumed Bank rate 3% higher than at origination as a guard against a potential property bubble.

The announcement in its latest Financial Stability Report has been met with concerns that it will affect ordinary mortgagees rather than cash buyers, wealthy overseas buyers and buy to let landlords who are credited with pushing up home prices in London and the South East.

‘The recovery in the UK housing market has been associated with a marked rise in the share of mortgages extended at high loan to income multiples. At higher levels of indebtedness, households are more likely to encounter payment difficulties in the face of shocks to income and interest rates. This could pose direct risks to the resilience of the UK banking system, and indirect risks via its impact on economic stability,’ the report says.

‘While the Financial Policy Committee does not believe that household indebtedness poses an imminent threat to stability, it has agreed that it is prudent to insure against the risk of a marked loosening in underwriting standards and a further significant rise in the number of highly indebted households,’ it adds.

The FPC has recommended that when assessing affordability, mortgage lenders should apply an interest rate stress test that assesses whether borrowers could still afford their mortgages if, at any point over the first five years of the loan the Bank Rate were to be 3% higher than the prevailing rate at origination.

Council of Mortgage Lenders director general Paul Smee said that while the new affordability stress test will clearly ensure resilience to shocks, limiting the level of a lender's lending to no more than 15% of new mortgages at 4.5 times income or above and none at all for Help to Buy guaranteed loans is likely to impact the London market. He pointed out that nationally, 9% of new loans are at 4.5 times income or more, but the figure is 19% in London.

‘It's important not to confuse these measures, which are designed to ensure financial and economic stability, with wider housing policy, for which the Bank is not responsible. Additional housing supply to help correct the imbalance between supply and demand is the main way of relieving affordability pressure and household indebtedness attributable to mortgage borrowing over the long term,’ he added.

Peter Williams, executive director of the Intermediary Mortgage Lenders Association (IMLA), said that the mortgage market remains subdued by any historical yardstick and while the FPC is right to voice concerns at any emerging trends which could rock the foundations of financial stability, it would be wrong to assume that rising house prices automatically mean household debts careering out of control.

‘Sweeping caps on mortgage lending would be ill suited to a climate where cash purchases are rising, mortgage debt is shrinking in real terms and home owners are putting a combined £10 billion of equity into their homes each quarter,’ he said.

‘Limiting the opportunities for hardworking, creditworthy consumers to buy or remortgage would only amplify the advantages already enjoyed by cash buyers, foreign owners and buy to let landlords, particularly in the South where the housing supply shortage is especially acute,’ he explained.

‘Coming down heavily on mortgage lending would be like trying to dim the lights by switching off the electrics. There are clear signs that robust income stress tests and underwriting standards under the Mortgage Market Review (MMR) are doing their job, and there is a danger that further constraints would miss their target and create new problems while doing little to control house price inflation,’ he added.

According to Simon Crone, vice president for Mortgage Insurance Europe for Genworth, limiting the proportion of high loan to income (LTI) mortgages is a well intended move, but it will mostly affect London and adds to a series of interventions that encourage growth with one hand and rein it in with the other.

‘To guard against the need for another re-think, we need to work towards a fully planned and sustainable framework that maintains a lasting balance in the mortgage market. Canada, for example, has done exactly this by making wider use of mortgage guarantees as part of a comprehensive system that keeps lending from accelerating too fast in times of economic growth. Mortgage insurance provides a more targeted and sustainable means of implementing sensible LTI limits and promoting good underwriting practice. This is essential to prevent the build up of risk and to improve the resilience of the financial system without the need for extraordinary intervention,’ he pointed out.

‘Such a move would also provide much needed clarity on the future of high loan to value (LTV) lending post Help to Buy, which is more important than ever following today’s announcement. Moves to tighten affordability tests so soon after the Mortgage Market Review (MMR) threaten to cast a further shadow over the first time buyer market, which already recorded the slowest growth in April when the new rules came into play,’ he said.

‘The recovery of high LTV lending has relied on the government initiative, and the use of private mortgage insurance to fulfil this role beyond 2016 could support greater first time buyer activity while encouraging the necessary discipline to manage risk,’ he added.

It could have been worse, according to Lucian Cook, Savills UK head of residential research. 'The measures put in place today are clearly designed to limit banks’ exposure to lending that will pose risks in a higher interest environment rather than cool the market per se. Accordingly the measures announced today are not nearly as draconian as they might have been had the FPC applied absolute loan to value or loan to income caps at an individual mortgage level,' he explained.
 
'Further stress testing of affordability at different interest rate scenarios is likely to have the most significant impact on the market. Acting in conjunction with the mortgage market review, this will inevitably act as a further constraint on buyers’ ability to borrow. It should prevent the mortgaged housing market getting into dangerous territory and will act as a drag on price growth in that part of the market,' said Cook.
 
'For all the criticism of Help to Buy and the rise in high loan to value lending, our view is that these measures reflect the fact that we are not currently witnessing a mortgage-fuelled housing boom. Already there are signs that the mortgage market review is tempering demand and this alone is likely to trigger a slowing of house price growth,' he explained.
 
'Our latest prime London indices show that even in the equity rich markets, which have underpinned the housing market recovery to date, house price growth is beginning to slow. Year to date growth across prime London has slowed to an average of 4.9% compared to 11.3% growth across 2013 as a whole,' he added.